Cheap Money Bankrolls Wall Street's Bet on Housing

Thursday, 2 May 2013 | 9:33 AM ETReuters

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Michael Marchillo, a plumber, has been trying and failing for months to buy a bigger home for his family here in Sin City. He was pre-qualified by a bank for a $130,000 mortgage, which a year ago would have landed a typical three-bedroom home in the area. No more. Now, the 36-year-old says, it's hard to compete with "greedy investors" who come to the table flush with cash for quick deals.

Marchillo is on to something. The once-beleaguered Las Vegas housing market has been on fire since investment firms led by Blackstone Group, Colony Capital, and American Homes 4 Rent began buying homes here some eight months ago, backed by $8 billion in investor cash to spend nationally.

These big investors and a handful of others have bought at least 55,000 single-family homes across the U.S. in the past year. In the Vegas area alone, they have accounted for at least 10 percent of the homes sold since January 2012, according to a Reuters analysis of housing transactions.

That added firepower helps explain why home prices in this metropolitan area of 2 million people are up 30 percent over a year ago, far more than the national average of 10 percent. Permits for new home construction are up 50 percent, twice the national average.

Local real-estate broker Fafie Moore says private-equity firms and hedge funds have largely "crowded out" local buyers like Marchillo. That's because the investment firms have broadened beyond their initial focus —buying homes at foreclosure auctions. Now, they are also bidding for homes listed by private owners and banks.

In a sign of how freely the money is flowing, Moore notes around 60 percent of all sales are in cash these days.

Fellow broker Trish Nash said she has seen cases where a home gets listed and quickly draws a dozen bids, many in cash. Realtors are talking about a mini-bubble forming here.

"There is an artificial appreciation in our market," says Nash. "I know (the big investors) say they aren't going to be flippers, but for them it is all about the bottom line."

Blowing Bubbles

Las Vegas would seem a highly unlikely locale for a new housing bubble. There are at least 20,000 homes in some stage of foreclosure, and the jobless rate hovers near 10 percent, some two points above the U.S. average. A healthy housing market depends on people having good-paying jobs so they can accumulate down payments and finance their mortgages.

But the surge here has another origin: the Federal Reserve's continuing push to buttress growth in the wake of the 2008 financial crisis, itself the product of the bursting of a much larger housing bubble.

The central bank is pumping the economy full of cash by buying assets such as U.S. government bonds and mortgage-backed securities. Added demand for those assets is pushing their prices up, and hence their yields down. That's encouraging people to put cheap credit to work at riskier activities that can spur growth—for instance, buying shares in new companies, investing in oil wells or renovating houses.

Prodding investors further out on the so-called risk curve is part of what the monetary mandarins had in mind. But in treating the consequences of the last bubble, the Fed is now spawning new, smaller manias like the Vegas rental rush.

Why Vegas in particular? The market tantalized investors because the crash was so deep here. Even after the recent bounce, prices today are 56 percent below where they were before the bust. The thought was that any recovery would mean easy money. The dry climate makes for lower maintenance costs, too. Similar logic applied to other beaten-down sunbelt cities.

Not everyone is a believer. "The Vegas housing market has only firmed because of speculators," said Jason Ader, a New York money manager and former Wall Street casino analyst who invested in foreclosed homes in Phoenix a year ago but bypassed Vegas. "Vegas is only doing well for now because of the greater-fool theory"—the belief that even if an investment is iffy, you can sell it at a gain to someone else. That kind of thinking is typical of bubbles.

Cracks are showing in Vegas and beyond. Here, rents on single-family homes were down an average of 1.9 percent in March from a year ago. In other regions targeted by institutional buyers, such as Phoenix, Southern California, Atlanta, and Florida, rents are either falling or flat, according to online real estate service Trulia.

It's also taking longer than planned for institutional buyers to hire contractors, renovate the acquired homes and get them rented out. Industry insiders estimate that roughly half of the more than 55,000 homes acquired by institutions over the past year in the U.S. have yet to be rented.

The combination of rising acquisition costs, prolonged rental lead times and declining rental income is disrupting the spread-sheet analysis behind Wall Street's bet. That could pose problems for what once seemed like a slam dunk. It could also give pause to stock-market investors as some players list their shares. American Homes 4 Rent, based in Malibu, Calif., has said it expects to file soon for an initial public offering.

"I think it's a little late to start investing in single-family homes, because some of these larger firms are price-indiscriminate, and pushing prices up," says Philip Barach, president and co-founder of DoubleLine Capital, a fixed-income mutual-fund firm with $56 billion under management. DoubleLine reviewed the foreclosed-home trade a year ago but passed on it. "In some markets," Barach says, "they are the only bidders."

To Flip or Not to Flip

What excited Wall Street in late 2011 was the prospect of getting homes at 30 to 40 percent discounts, using a combination of investor dollars and cheap financing made possible by the Fed's easy-money policies. The gross annual rental return envisioned on a $100,000 home ranged from 14 percent to 27 percent, depending on the mix of investor dollars and cheap financing. That didn't include expected annual returns as high as 10 percent from the appreciation in home values.

Those projected returns are eye-popping, considering that the yield on the 10-year Treasury bond is 1.70 percent and big investors can borrow at between 3 and 4 percent.

The calculus: With millions of Americans coming out of the housing crisis unable to get a mortgage because of dented credit histories, renting would be the only option. In a few years, after repairing their credit scores, many of those renters would be buyers.

That was then. Now, some investors are exiting the market, scaling back or dialing down expectations.

Early last year, Oaktree Capital Management agreed to provide up to $450 million in equity to real estate investment firm Carrington Capital Management for its foreclosed-home acquisition program. Carrington was projecting an internal rate of return of 25 percent over a three-year period for its portfolio of single-family homes in several cities, according to a marketing document.

Oaktree is now reluctant to commit more money to the trade after souring on the buy-to-rent strategy, said people familiar with the firms. Oaktree saw returns on rents compress and no longer is comfortable with Carrington's initial heady yield projections, they said.

In October, hedge fund Och-Ziff Capital Management Group cited a narrowing in rental income for its decision to put its book of 300 homes in Northern California up for sale—a process it has just about completed.

"The math for investors is looking very different," said Jed Kolko, Trulia's chief economist.

Vegas home prices are up 30 percent over the past year, with the median home now selling for $161,000, according to the Greater Las Vegas Association of Realtors. Much of that appreciation has come since June, when the institutional buyers began to make their presence known.

Blackstone, which entered the Vegas market in November, has bought over 400 homes at foreclosure auctions, from banks and private listings. Nationally, the private equity firm has bought over 24,000 homes. It is using a combination of $3 billion in investor dollars and a $2.1 billion line of credit arranged by Deutsche Bank.

In Vegas, Blackstone is making up for a slow start. Local realtors Moore and Nash said they've begun getting calls from Blackstone, asking them to contact the firm if pending sales fall through. Colony is buying some newly built homes because of the limited supply of foreclosed homes.

Representatives for Blackstone and Colony said they are not daunted by the slump in rents or delays in readying units for tenants in the half-dozen markets they are largely buying in. The firms said they aren't buying foreclosed homes to flip them and are committed to building out subsidiaries that manage and rent single-family houses.

"This is more of a marathon than a sprint," said Paul Fuhrman, chief investment officer of Colony's single-family home subsidiary, which has acquired more than 8,000 homes.

Marcus Ridgway, the new chief operating officer of Blackstone's Invitation Homes subsidiary, said his firm's strategy doesn't rest on the performance "of one single market, and can rely on other markets to balance returns."

American Homes, which has bought at least 14,000 homes nationally, did not respond to requests for comment.

The Vegas market has unsteady legs. Statistics compiled by the University of Nevada at Las Vegas show some 40,000 homes are largely vacant—8 percent of the metropolitan area's single-family housing stock. Housing research firm RealtyTrac estimates there are 20,000 single-family homes in the metro area either owned by a bank or in some stage of foreclosure.

Some 52 percent of all homeowners still owe more on their mortgages than their residences are worth, more than any other state, according to CoreLogic. It's even worse in some neighborhoods. An analysis by RealtyTrac for Reuters found that in about half of the zip codes in the Vegas metropolitan area, at least 70 percent of homeowners not in foreclosure were under water on their mortgages.

Economists say with unemployment in Nevada at 9.7 percent, there's not much real growth underpinning the surge in home prices and new construction.

A big source of the buying is the big guys. Between them, Blackstone, Colony, American Homes and a joint venture involving Apollo Global Management and Haven Realty Capital have acquired more than 1,500 homes in Las Vegas. A half-dozen smaller investment firms are also buying homes.

Much of the buying is in a crescent that begins in North Las Vegas and runs along the city's western and southern edges. This is where some of the newest homes have been built and where price appreciation has tended to be greatest, realty records show.

With Vegas largely dependent on gambling, tourism and conventions for growth - discretionary spending that tends to recover last—it's unclear whether the city can support broader buying.

"Betting on home appreciation is not a sure thing," said Yale University economics professor Robert Shiller, one of the designers of the S&P/Case-Shiller index, which tracks housing sales and prices. "Right now we have the Fed with a massive subsidy to the housing market, but you can't have a housing recovery without a jobs recovery."

Casinos and Scorpions

It's not all gloom. Gambling revenues are up over last year. Boosters point to the recent acquisition of the long-stalled Echelon casino and resort complex—one of several unfinished eyesores on the Las Vegas Strip—by a Malaysian gaming company for $350 million. Many also are banking on a plan by Tony Hsieh, founder of Zappos, to move the online shoe retailer from the nearby town of Henderson, Nev., to downtown Vegas and pour in some $350 million to create a tech incubator.

Another selling point: The city has a young housing stock, and so properties require fewer renovation dollars than homes in most other battered markets. Vacant homes tend to fare better in a desert climate such as Nevada's, too—though some investors say scorpions nesting in empty homes are a problem. And since most homes have rock gardens rather than lawns, landscaping costs are low.

In homes that don't need major surgery, institutional buyers are spending between $10,000 and $15,000 on kitchen appliances, granite countertops, carpets and a paint job. In markets with older homes, renovations can cost $25,000.

One spot the institutional buyers are targeting is Enterprise, an unincorporated town in Clark County. With a population of 108,000, Enterprise, formed only in 1996, has lots of new homes. In 2000, the town had just 15,000 residents. So far, big investors have bought more than 150 houses there, according to county property records, in many cases buying several places on the same street.

Kathryn Kay Chapman, a 47-year-old project manager, rents a two-bedroom house here with her boyfriend and has been looking to purchase a place nearby. Neither can qualify for a loan because of tarnished credit histories, so they decided to buy at a foreclosure auction.

The couple scraped together enough cash to make a bid on a three-bedroom home they've been eyeing. Their sweet spot: between $120,000 and $140,000.

On April 22, the house came on the block at one of the auctions held each day in the parking lot of the Nevada Legal News, a few blocks from the Strip. The bidding began at $97,200. But the couple had made a beginner's mistake: Their cashier's check was found to be improperly drawn and they couldn't participate.

It likely wouldn't have made a difference. The place sold for $155,000, above their limit. Chapman says they may try again, though she suspects they'll be outgunned. We know there is a minute chance we get anything," she says. "The most frustrating part of all this is how home prices keep going up and up, yet you have so many empty homes."